A man walks down the street, prominently displaying his mobile phone. His T-shirt is branded, as are his shoes, and the billboards he walks past flip between car advertisements. Nothing unusual there - except that this is a video game.

The games industry is thriving, and is estimated to be worth £23bn worldwide this year alone. Reports this month that Microsoft might spend $400m (£211m) buying Massive, a New York-based games advertising firm, has thrown a spotlight on in-game ads - one of the world's fastest-growing media markets.

"Games are big business," says Paul Lee, a technology and media analyst with Deloitte Research. "And there's been quite a significant change in complexity and time spent on them. Now video gaming is probably the most important new media around - even more so than web browsing."

Unlike the real world, where advertising assails us from every surface, virtual environments have, until now, remained relatively free of marketing. Often, game makers have placed their own fake advertising inside games to pump up the perception of reality. But the situation is changing, partly due to a new generation of internet-friendly games consoles.

Some market analysts forecast that game advertising will be worth up to $2bn by 2010. Although some forms of in-game advertising - such as product placement and sponsorship - have existed for a number of years, a new market in "dynamic" advertising is quickly opening up thanks to the rise in internet connectivity.

New technologies enable companies to drop live adverts into games straight from the internet: on virtual billboards, virtual T-shirts or virtual racing cars. In theory, this makes it possible for a regular stream of new ads to be tailored to the player's interests and built to fit the environment of any game. In practice, a number of developers, marketers and publishers have already jumped on the bandwagon.

"The Microsoft news is a very positive thing," says Ed Bartlett, vice-president of IGA Worldwide, another leading in-game advertising company. "It really comments on how serious this market's going to be, and guarantees that there's going to be continuing support."

Legitimacy

Mr Bartlett says that the legitimacy provided by Microsoft's move has helped stimulate interest in dynamic advertisers, who take information such as a player's age, location and tastes into account in placing targeted marketing, without ever breaking the feeling of a game world.

Google has, of course, used a similar concept - placing advertising on your screen, based on what you are doing and where you are - to build a multibillion-dollar business in web advertising.

For advertisers, the appeal of in-game ads is simple: in a media environment where young men, in particular, are spending more time playing games than watching television, in-game advertising offers brands a crucial new line of approach.

"It's going to be a long time before we see a Colgate advert in Grand Theft Auto," says Paul Jackson, an analyst with Forrester Research. "But some of the edgy brands wouldn't have so much of a problem advertising in games like that."

Some people are more sceptical about the medium-term growth prospects, and say that although in-game advertising has a place, it requires several factors to link together before it can become a serious player.

But games publishers and developers are enthusiastic about the possibilities, and keen to stress that new revenue streams could provide a vital lifeline for them. British companies are not alone in struggling to cope with increasingly large budgets and short life cycles of video games. A typical top-rated title may take several years to develop and cost in the region of £10m, which many investors deem too risky.

"Video games are big business - but they are constituting more and more financial risk," says Paul Lee, of Deloitte Research. "If you look at the next generation of games, the cost could go up to $20m. Now compare that to an Oscar-winning film - there isn't much difference."

Originality

The result of such expensive productions has been a slow decline in levels of originality and a reliance on an endless torrent of sequels designed to put money in the bank. However, some developers think that the extra revenue from in-game advertising could reduce budgetary pressures and buoy Britain's host of innovative but fragile games companies.

"I think that in the UK and Europe we're quite brave with our games," says Peter Chan, of Codemasters, a British-based publisher and developer. "But if you've got the opportunity to do a game that you once wouldn't have, because there's now a new revenue stream, then people will take that chance. There are risks that some people will go too far ... but for any publisher going forwards, it is a fantastic opportunity."

According to some insiders, market growth shows no signs of stopping. Audiences are expanding, bringing in more female gamers and those over 40, who have traditionally eschewed the medium. The technological capabilities are being stretched all the time, with high expectations of Sony's PlayStation 3. Even handheld devices are in on the act. Both the PlayStation Portable and Nintendo's DS have built-in wireless internet connections, as does a new generation of mobile phones.

Peculiarly enough, there is no real backlash against the prospect from grassroots gamers. Punters are tempted by the idea of more innovation or cheaper prices but they also appreciate the realism of changing advertising when it is placed properly. "In some genres, if done well, it seems like a win-win situation," says Paul Jackson of Forrester Research.

Ed Bartlett, of IGA Worldwide, points out: "Gamers say that these things are adding measurably to the in-game experience. It's one of the few media where that happens."